Financial markets are worried about rising U.S. government debt and grappling with the question of who’s going to buy $20 trillion of debt over the next decade? How much debt is “too much?” What would a full-blown crisis in the U.S. Treasury market look like, and what could trigger one? A new Must C report from Citi Research dives deeply into these important questions.
In the report, Global Chief Economist Nathan Sheets and a team of economists and strategists note that since the pandemic’s onset, the debt of the U.S. federal government has risen from an already high 80% of GDP to nearly 100% of GDP.
Looking forward, budget deficits are expected to hover at 6% of GDP or higher, with the debt poised to rise 120% over the next decade, far surpassing the post-WWII peak. At the same time, issuance of Treasuries is expected to be substantial.
The report makes the point that the U.S. is unlikely to grow its way out of its debt problem, meaning politicians will need to rein in budget deficits. But that’s a tall order given Democrats’ and Republicans’ positions on spending cuts and tax increases they say. The report’s authors think an adequate remedy will require a combination of both, with tough reforms to entitlements and defense needed to get traction on expenditures.
Three events have brought these issues to the fore: The debt-ceiling standoff highlighted U.S. governance challenges; Fitch downgraded the U.S. sovereign rating; and the Treasury announced its upcoming borrowing needs, underscoring that forthcoming issuance will be substantial. Meanwhile, 10-year Treasury yields rose roughly 100 basis points from late July through October and 150 basis points from early May.
To organize its analysis, the team considered a series of questions related to U.S. debt, explored in depth in the full report. These questions fall into five broad categories, which can be summarized as overarching questions in their own right:
- How high is the U.S. debt, and what would deleveraging look like?
- What potential challenges have emerged?
- What are the risk scenarios?
- What lessons might we draw from the international experience?
- Short of a full-blown crisis, do high debt levels matter?
The team’s analysis, offered through its answers to those questions, yielded several primary conclusions:
- High U.S. federal debt levels are slated to approach 115% of GDP during the coming decade. These high debt levels, along with entrenched deficits and worries about issues, have helped push Treasury yields higher in recent months. But other factors have also driven yields.
- As debt levels rise, there’s no way to predict danger thresholds or the amount of debt that’s “too much.” But the authors warn it’s unwise to test those thresholds, and see the prudent path for fiscal policy as, at minimum, to not push debt further above today’s elevated levels.
- A full-blown adverse scenario remains unlikely, but last year’s UK gilt crisis offers a cautionary tale. Such a scenario could see a sharp, unexpected deterioration in the market appetite for U.S. Treasuries, leading to sharply higher yields and rising risk premiums in credit and equity markets—stresses that would quickly spread to other financial markets given the dollar’s status as the global reserve currency.
Lest they sound too pessimistic about the potential challenges posed by U.S. debt, the team notes that the U.S. economy continues to possess deep resources and significant strengths. The economy is the world’s largest and growth has proved resilient in recent years, so its capacity to pay debt is high.
The U.S. private sector is less indebted than in many similarly situated countries, and U.S. asset positions are strong. The U.S. dollar remains the world’s reserve currency, with Treasury markets offering investors unique depth and a range of instruments. And the Fed’s now-entrenched independence offers an important safeguard against high inflation.
The analysis points to three potential scenarios for the U.S. and its indebtedness.
-The first possible outcome—and the most likely one, in the team’s view—is that markets’ current discomfort about the U.S. debt trajectory will dissipate, with the core strengths of the U.S. economy giving investors confidence to buy Treasuries despite political noise.
-A second scenario is that rising debt levels, while sustainable, will lead to meaningful headwinds. This outcome is arguably similar to what Japan has experienced in recent decades. One potential consequence: High debt drives uncertainties for the private sector and weighs on household and business spending.
-The third scenario envisions a full-blown crisis, one that would do serious damage to the Treasury market and global financial markets—an episode resembling the gilt-market stresses, though more sustained. But the team places the lowest probability on such an outright disruption.
A redacted version of the original report is available here. (7 November 2023)
Citi Global Insights (CGI) is Citi’s premier non-independent thought leadership curation. It is not investment research; however, it may contain thematic content previously expressed in an Independent Research report. For the full CGI disclosure, click here.
